Dividends: The Way to Win in a Losing Decade

Jeremy Glaser: For Morningstar.com, I'm Jeremy Glaser. I'm here today with Josh Peters, Editor of Morningstar DividendInvestor to take a look at how the dividend market is doing and his outlook for the rest of the year.

Josh, thanks for talking with me today.

Josh Peters: I'm happy to be back. It's been a few weeks.

Glaser: So what are some of the big developments that you've seen over the last month or so that have surprised you or that played into some of your thoughts?

Peters: Well, I'll tell you, you watch the stock market over an extended period of time and have the opportunity to kind of look back at it, after perhaps not being in the thick of day-to-day, minute-by-minute action, and I did see a lot of running in place. And I can look back over the last year and see a lot of running in place, a lot of volatility, a lot of activity, a lot of trading, a lot of vigorous arguments, bull-bear and otherwise, and yet, not a great result to finding result one way or the other.

You look back over quite a few years and see a lot of volatility, but not really conclusive results for investors. I don't think that it's at all unfair to start referring to the last decade as being the lost decade, and I'm starting to wonder if we are looking at yet another decade where investors could be looking at a stalemate for their portfolios.

Glaser: One of the things that has been somewhat of a bright spot over the last year have been corporate earnings and again this quarter for the most part corporate earnings have looked very strong. Do you think that foretells Boards of Directors getting together and saying, okay, actually we are going to raise the dividend and that we could see the yields on the S&P look more attractive in the coming months, just thanks to increases.

Peters: Well, no. I really wish, but I mean if you start to put it in a historical context, the magnitude of the problem becomes really clear. To get it back to a yield on the S&P 500 of even 3%, which up until 1994 was the old floor on market yields; that was really an indication that market was widely overvalued. Just to get to 3%, you need a 50% increase, a $100 billion increase in dividend payments by American-listed corporations.

Now most of the dividends that are being paid today are already coming from companies, whether in the telecom, utilities, consumer staples that already have really appropriate payout ratios, you can't really expect AT&T to double its dividend when it already pays out 70% plus of earnings.

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So you're looking at a big swath of corporate America in technology, healthcare outside of the big drug companies, financial services, hopefully they will be in a better position to start paying some dividends, have some regulatory pressures eased, but we still haven't seen that yet. Even industrial and material stocks are neither just not coughing up the cash.

So it's going to take I think a fairly dramatic change of mindset to restore a good dividend yield profile to the market overall, and if we don't get that then it's a slow grinding process, where dividend payments maybe continue to rise by a mid single-digit type of number, but stock prices are stagnant long enough for that to compound into a higher yield.

 I don't think that's the outcome most people want, but unless corporations change their behaviors, are returning these huge earnings that they are generating, huge cash flows that their generating directly to shareholders through dividends, I don't really see how this situation is going to improve much.

Glaser: So from the retirement investor standpoint, what would your advice be to them given that we could have another lost decade, where should they be putting money? Is buying the 3% Treasury bond is that really where they should go.

Peters: Well the advantage of having a 30-year Treasury bond or say a 10-year Treasury bond that's going to yield 3%, is that you know exactly what you are going to get, 10 years you are going to get the money back. But you don't know is what that money will be worth. We don't know how high inflation or for that matter how low inflation may be. There is still a lot of uncertainty.

If you are buying stocks and at least hypothetically, you are getting the claim on a real operating business that if the economy does move in a higher inflation, you should be able to benefit from that. So to me I would still prefer to own stocks, because of their longer term inflation threat, even if its 3, 4, 5 years out. I don't want to line up with a 10- or a 30-year commitment to a fixed income instrument.

So, the question really becomes, what kind of stocks can help me dodge the loss decade. The way to evade this problem, the way to win in a losing decade is to get paid directly, to be paid through cash dividends first, to look further companies that are not going with the tide and hording cash or using on share buybacks, using it to raise their CEO's pay, using it to make huge acquisitions and pay a bunch of investment bankers.

The companies that actually say the shareholder here is first, and we are going to put that priority to work by putting a good cash dividend out there, those companies have tended to do fairly well for shareholders over the last 10 years.

You look at a huge company like say Wal-Mart, Wal-Mart raised its dividend for 30 odd years in a row, but up until recently its yields has been very small. Even today, it's only a little bit better than 2%. The money just simply isn't there. Its stock has gone nowhere in the last decade. You didn't earn any positive return from owning a stock like Wal-Mart, when its yield started at a very low level and the stock price is very high in relation to dividends and earnings.

You look at how utilities have performed or master limited partnerships, pipeline companies that are geared toward paying out big dividends, consumer staples companies, I mean almost anything that had a higher yield attached to it outside of the financial services sector, has actually had a pretty good decade.

There have been a lot of returns you could put in your pocket and keep, and that is because the connection was never broken. You still got companies that are really working directly for their shareholders.

I think that those are still the kinds of companies that you want to own for the decade to come. I don't know, maybe the market is about to take off and go into huge rally mode. But I don't think there is a basis for it there. You have to be an individual stock picker and you let dividends help pick your stocks.

Glaser: Josh, thanks for taking the time today.

Peters: Well, wish I had more positive story to tell to be honest, but this is where the logic is leading me, and I think it's what's best for investors as we look out over another decade.

Glaser: Thanks again, Josh. From Morningstar.com, I'm Jeremy Glaser.